kirkydu (91.55)

2012: Another Year the World Won't End

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Throughout 2011 we heard proclamations of doom and gloom from market pundits to gold traders to vote seeking politicians to assorted snake oil salesmen to the converts of ancient Mayan religion. Each has a version of a coming apocalypse, some including hyperinflation, 50% unemployment, widespread famine, world war or complete destruction of the globe due to galactic forces beyond our control. In my estimation, each is about as likely as the other to occur, that is, not very likely at all.

If you will recall, on several occasions back in 2007 and 2008, I discussed the vast financial problems that the globe faced. Today and recently, those who missed the actual financial collapse are running around telling us about a coming new bigger and badder financial destruction to come. To put this as plainly as possible, they are very late to the party.

While it is possible, if not probable, that the global economy and financial markets will operate on very uneven paths for an extended period, the big financial debacle has already occurred. Could we see another stock market drop of 30%? Absolutely. Is real estate likely to keep falling in the short term? Probably. Will governments continue to politic us into migraines and slow solutions? What else is new.

But, and this is important to observe, there are forces out there that are creating balance as you read. The slowing of developed economies is being offset by growth in developing economies. The forces of deflation and the forces of inflation are nearly balanced on aggregate (though as any shopper can tell you are uneven from item to item). The slow methodical approach of Germany and the European Union to gradually fix Europe is neutering quick clicker finger traders who are betting on financial turmoil in the hopes of making a fast get rich strike.

All in all, despite being unsure of things a year or so ago, I am quite confident that my newfound optimism is well placed.

First and foremost, Europe is exceedingly rich. The nations of Europe sit on so much accumulated wealth that while an unwinding of the Euro is possible, it would not be catastrophic to markets long term, in fact, for the United States it would probably be good. Yes, there would be a great buying opportunity in stocks as markets trembled, but it would not last, as a rebound would be inevitable and probably as swift as America's in 2009-10.

The big threat to the global financial system was that Greece could outright default on its loans setting off a series of events that were uncontrollable. The threat that Greece could default is still there. However, the threat that it would be the first domino in a wider systematic death spiral is virtually gone. Over the past few years, 2011 in particular, Europe has sufficiently isolated Greece, small to begin with, from being a threat to its neighbors and their banks.

As the Germans and French have strung along European problems fixing things a bit at a time, much to the dismay of some financial market speculators and pundits, it has been the right prescription.

One of the hurdles that the Europeans faced was adding capital to their banks, which has largely been done through actions of the European Central Bank, as well as, our Fed. Interestingly, another addition to European bank capital, though relatively small, has been the interest that speculators have paid to banks in margin interest as they bet against those same banks.

Time is not on the side of speculators as they must pay to play. The Germans seem to be fully aware of this and have been happy to patiently work through Europe's problems forcing speculators to bow out or blow up. See MF Global which couldn't hold things together waiting for their bets to pay off. If this is not a global example of "don't fight the Fed" I don't know what is.

Europe will continue working through its problems and solving those problems a bit at a time. They will not allow speculators to crash their economy outright, or their markets, even if their actions are questionable ethically in the eyes of some questionably ethical market speculators.

America is Slowly Ascending, not Descending

As I have written about at MarketWatch.com of the Wall Street Journal network, America is no longer on the slide down, we are on the ladder up. I have a very simple premise. The United States is slowly ramping up production of energy, metals and food throughout the country. This is having multiple positive effects, slow to develop to the naked eye, but there nonetheless, including, increased employment, stabilizing prices for food, energy and goods, and increased high margin exports. All of this adds up to a very powerful set of economic forces which will drive the American economy for decades.

It is still necessary that the United States flattens its spending levels and corrects tax imbalances, despite the improving long term economy. We still must balance the money coming in with the money being spent. We have until about the end of the decade to adjust in order to avoid a crisis, as that is when our debts (bonds) truly start to come due.

There will be some hard choices to be sure, but we will make them one way or the other. As long as people realize that the riches of America's natural resources are here for all and not just a few, and recognize the environmental and financial issues that come with exploiting our resources, things will work out.

Buying Last Year's Losers

In 2011 I started buying certain assets that were down 30% or more. Unfortunately, some of those assets continued to fall. It is from this experience the saying "don't catch a falling knife" comes from. That saying is a generally false premise however. It is almost inevitable that those who buy near market and asset price bottoms do the best long term.

Already this year several of the things that we bought in 2011 are up far ahead of the markets. While nobody knows how things will shake out the rest of the year it is becoming more possible by the day that last year's losers might very well be this year's winners. Luckily for us, we have a few of those.

An important fact to know is that the total amount of stock available on American stock exchanges shrunk significantly last year as American corporations bought back more stock than they have issued in the past year. This generally happens when companies feel their stock is cheap or at least they have the money to do it. This is a powerful catalyst in waiting for stock prices as the supply has shrunk and at some point demand will again climb from various investors domestic and foreign.

Many international markets got crushed in 2011 pushing valuations to very low levels. China was particularly hard hit as they came to the end of a five year plan. Their new plan is starting now, and generally these new plans come with quite a bit of front end financial support. As a creditor nation, China can afford to spend some money on growth. The combination of markets reverting to the mean on valuations and a strengthening United States seems nothing but good for equities in the intermediate term, though, once again I'll say, who knows what can happen in the short term.

For the readers who have been finding me online, as well as my clients, see my articles at MarketWatch.com and Motley Fool for some specific ideas and insight on what I am doing. You can keep track of when my articles come out by "liking" my business page on Facebook, following me on Twitter or seeing the In The News section of this site. Also coming soon for local readers, I will be doing a series of financial articles in the community "Now" papers beginning in February. Finally, if you haven't watched my Fox Business interview yet in which I discussed European stocks, take a peak.

This letter contains forward looking statements that may not come true. Past performance does not guarantee future results. This letter is intended for informational purposes only, and reflects only my thoughts and opinions in general, and do not constitute individual advice. Opinions expressed may change without prior notice.

Great article, although I disagree that America is slowly ascending. As Reinhart and Rogoff have shown with their emperical research: as public debt exceeds 90% of GDP, countries have a difficult time achieving more than 1 or 2 percent growth.http://papers.nber.org/papers/w16827

I'd say 2012 will be a stagnant year for the U.S. economy, as will the rest of the decade.

Rienhart and Rogoff did not factor in for natural resources wealth or the effect of being the defacto reserve currency. The United States has both. While I don't want to see debt much higher, the simple fact is that so long as we bring our annual budget roughly into balance by about the end of the decade, we are in great shape.

The fight we are in right now is how to balance the annual budget. It'll be tough. We will need both higher revenue and flattened expenditures, and a way to do it without welching on promises to people who are retired.

Interesting analysis. I've been off the "world ending" bandwagon for a while, however, I dont think the financial volatility is over due to the monetary situations amongst the old guard economies. Yes in reality, America may be improving, but financially its a circus with huge imbalances that need to be fleshed out. Personally, because of this I think the stock market may lag the real economy for a while. I don't expect spectacular returns anytime soon. For the record I never predicted hyper-infliation. I see a new form of stagflation for quite some time (slow grow, increasing commodities prices) until these imbalances. Certain things just cannot continue. Treasuries can't continue to outperform with their subpar yields. Eventually interest rates will need to rise. Given the over-optimism in the financial industry, that is bound to ruffle some financial feathers. So while there may not be armageddon, I highly doubt we are going to have the highflying days of the 90s anytime soon.